Recently, a Wealth Club member inquired about how to determine whether a stock's valuation is palpable or not.
Obviously, there are tons of different ways to look at valuations - and entire books have been written on the topic.
But, one common method (and thankfully one that doesn't require 80,000 words to explain), is the comparable method.
This method can be used actually fairly quickly within research platforms of many full-service brokerages like Charles Schwab.
Below is a screenshot from Schwab's research platform showing various valuation-related metrics, comparing those of Beyond Meat (NASDAQ: BYND) to it's industry peers.
To get an idea of this stock's comparable valuation, any of the above metrics (ratios) for BYND can be compared to the subsequent stock symbols (i.e. BG, DAR, etc.).
Notice how BYND's "Price/Earnings" ratio has no figure. That's because they have no earnings to calculate the ratio.
Also notice how BYND's "Price/Forecasted Earnings" ratio is between 30 to nearly 100 times higher than it's peers.
So at first glance, it's logical for one to assume that BYND's stock is over-valued, and therefore a riskier investment.
However, it's important to keep in mind that there are lots of stocks that have been overvalued for a long time (i.e. Tesla), but because there is a sufficient amount of the market to continue pushing the price higher (this is often referred to as the "Greater Fool Theory"), the "over-valued stock" continues to advance.
This is why it's important to never rely on just one metric, nor put all of one's investment capital into one investment.
Valuation metrics are a valuable tool to add to your investment selection tool belt, because they can help you tip the odds in your favor. Although you wouldn't want to rely on them exclusively, there have been several strategies employed successfully over the years that relied heavily on metrics, including those of valuation.
Using the comparables method, one can get an idea of a stock's particular relative valuation. It may not be a silver bullet to picking the right stock, it will definitely help an investor make more informed decisions.
J. Patrick Nichols